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The More Things Change: The 2013 Broker-Dealers of the Year

Volatile markets, regulatory threats, higher costs and compliance burdens—how could these guys be so calm?

Photography by Tom McKenzie.

“What was the question?” Russ Diachok innocently asked.

It wasn’t as if the president and CEO of Geneos Wealth Management wasn’t paying attention to the discussion before him. As other participants attempted to prompt him, they quickly ­realized they too had trouble remembering the original question. Backtracking revealed they’d jumped from compliance to social media to next-gen to ­succession planning, all without a question in between.

It was a stark example of the ­increasing interconnectedness of issues related to the independent broker-dealer ­business. It was one of many themes to emerge from our meeting in Chicago with the 2013 Broker-Dealers of the Year.

This is the 23rd year that Investment Advisor invited producing representatives of independent broker-dealers to rate their BDs on 14 specific categories and a 15th, in which we asked for a rating on each firm’s overall performance and service to reps. Those firms that received the highest overall rating in each of four divisions (by size of their rep force) are the 2013 Broker-Dealers of the Year.

The four men who lead the winners this year gathered for a nearly full-day roundtable discussion in Chicago on July 31. While the discussion was initially seeded with questions from the hosts—John Sullivan, editor in chief of Investment Advisor, and Jamie Green, editorial director of the Investment Advisor Group—we were pleased with the interaction, cross-talk and resulting passion each participant displayed.

This year’s winners (or their firms) aren’t new to the process, yet one commented that although some of the players had changed, the issues remained the same. Whether or not it would prove true piqued our interest as the discussion got underway.

The leaders of the 2013 Broker-Dealers of the Year whose comments are below were: Terry Frank of Century Securities; Russ Diachok of Geneos Wealth Management; Tim Murphy of Investors Capital Corp.; and Eric Schwartz of Cambridge Investment Research.

An excerpt is provided here, but the 23rd annual BDOTY celebration continues online at ThinkAdvisor.com, where readers can find an extended version of the interview transcript, individual interviews with this year’s winners and behind-the-scenes video from the magazine’s photo shoot.

Regulation: The Never-Ending Story

Jamie Green, Investment Advisor: In October, the DOL is expected to release its fiduciary reproposal. What do each of you expect it to look like?

Tim Murphy, Investors Capital Corp.: The Department of Labor is introducing what they’re going to call the “conflict of interest rule.” The primary issue is no longer having the ability to charge commissions in IRA accounts. They’re introducing or defining fiduciary under ERISA separately from how the SEC is defining it. The Financial Services Institute has been active in meeting with folks on the Hill. [Editor’s Note: Murphy is a board member of the independent broker-dealer advocacy organization.] We’ve received positive responses. We’re getting support for our position. The primary concern is that the people who need the advice most aren’t going to get it. It’s typically a younger investor or somebody starting out; he’s encouraged to consult an advisor by a family member who just a left a meeting with their advisor. Well, the economics don’t work for the advisor. They may get an account open, but they may not get the appropriate, prudent advice to go along with it.

Green: You said you thought FSI was getting good response from folks on Capitol Hill. Do you expect the DOL will be listening to FSI?

Murphy: I can tell you the DOL will most likely not be listening to that. It’s our understanding that Phyllis Borzi and the DOL are headstrong in getting it done their way. They believe that what they’re doing is appropriate and the right thing to do. I think they’re missing the unintended consequences.

Terry Frank, Century Securities: I think that, philosophically, the senior people at the DOL believe that commissions are bad and fees are good. If they were able to do it, they would outlaw commissions in all accounts. They don’t have that power, so they’re taking a personal position. In many cases, a fee-based account is more expensive for the client. If someone has a relatively small amount of money, say $10,000, $20,000, and wants to open an IRA and doesn’t need any other advice for 10 years, can they pay a one-time commission and maybe a small trail that would allow them to call up the advisor and ask a question? Wouldn’t that be more appropriate than going to an advisor who says their account is too small to service? There’s somehow the assumption that commissions are evil and cost more and makes the advisor an adversary while a fee somehow automatically makes them holy.

John Sullivan, Investment Advisor: Can you give an example of a top performing advisor who has specifically rejected the fee route in favor of commissions and explain why?

Eric Schwartz, Cambridge Investment Research: I could list half a dozen, including one of my largest advisors. This particular lady has been with me a very long time. Her revenue is about $400,000 a year on almost $200 million of assets. You can do the math yourself, but if she was charging 1%, which most of her clients would happily pay, she’d be making $2 million a year instead of $400,000. She just doesn’t feel that it’s justified to charge that much, so she does it in a classic A-share and a trail model. Her husband’s been trying to convince her to switch for years, but in her mind she’s earning a reasonable income and they’re paying a fair price, and that’s the value she wants to deliver. The concept that if you’re doing fees you’re somehow a fiduciary, yet if you’re doing commissions you’re a salesman—it’s just not fair.

Green: Are you worried about the DOL rule, or do you think your reps are worried?

Russ Diachok, Geneos Wealth Management: I think our reps are worried. There’s a place for a commissionable transaction, just like there’s a place for fees, and I think it will be the clients that are hurt by this. It’s not so much us or our reps; our reps are trying to work with people who have money. If they can use a commission or a fee, then they typically go the fee route, but the investing public is going to be hurt by this more than advisors.

Green: What about the SEC’s fiduciary proposal? We assume it would state that anyone who provides advice has to operate under the fiduciary standard. Is that something you and your reps are worried about?

Schwartz: Our children could be retired before they sort all this out. There were 800 or 900 of our reps in a room at our national conference, and I asked, “How many people here treat both their commission-based clients and their fee-based clients in what they consider a fiduciary standard?” And I also asked, “Do you treat them one way or another?” There were a couple variations on it, but 100% of the reps said they treat their fee-based clients and their commission clients with the identical standard of trust and ethics. They already hold themselves to a fiduciary standard with both of them. Now, they couldn’t read out to you what the rules of a fiduciary standard are and check the list to show they’re doing it, but they don’t say, “Oh, here comes the commission client. We can take advantage of him,” and then, “Here comes the fee-based guy. I better be honest.” It’s absurd. Our advisors, on a theoretical basis, have no problem with it. They think all advisors should always hold themselves to a high ethical standard when they deal with all clients. I think the FSI would take the exact same position.

Those of us who have been through arbitrations over the last 10 years know that by the way they’re constructed and the way the complaints come in, they’re already holding us to a fiduciary standard. They’re saying, “You didn’t do what’s best for the client.” They don’t say, “You didn’t do what’s suitable.”

Murphy: I know a few firms that have gone through DOL audits. To Eric’s point, I think it’d be hard to find any advisor, whether or not they’re a fiduciary under the SEC’s current standard, who doesn’t act in their clients’ best interest. That’s how they get new clients. You don’t get referrals and build your business or stay in business, particularly in this environment, if you’re not acting in your clients’ best interest.

Green: The DOL fiduciary ruling and the SEC fiduciary ruling, those get a lot of press. On a day-to-day basis, are there other regulations, for example FINRA rulings, that are of more concern to you?

Frank: It seems like a lot of redundancy is coming out of the DOL. I don’t know why the DOL has all these different audits coming down when they can centralize some of them in an SRO. There might be a better way to go about it.

Schwartz: It’s certainly true that at any given moment, the only thing different between this year and next year will be a certain new regulation that’s coming down the pike. One of the newer ones that’s just showing its head is something that affects OSJs. If you are a super OSJ you will only be able to supervise two other offices. We’re certainly trying to figure out what that means.

Green: Is it important to be on those FINRA regional committees in order to have input into the process?

Diachok: I think it’s important, whether it’s at our level or compliance people, to participate in the FINRA committees and have a voice. We try to always keep somebody at our firm in the district committee queue. But what happens when you go to those meetings is not everybody is open and very participatory. Some people feel intimidated in that environment for whatever reason and don’t say much. That doesn’t really help.

Schwartz: It’s certainly important because you have to at least try to influence things and have regulators better understand the membership. I think most people who have been doing it a long time would say that from the member’s perspective, the influence is much less than 10 or 20 years ago. I think it’s the opinion of most that calling FINRA a self-regulatory body is really not the proper terminology; 20 or 30 years ago it was a self-regulatory body. Today, the members have no power. It has more teeth in it than the SEC, which is a federal watchdog, as evidenced by the regulation of broker-dealers versus the regulation of RIAs; they can’t even get out there and audit 30% of RIAs. If the SEC was a branch office of ours, FINRA would shut them down for failing to supervise the people.

Murphy: If we don’t stay actively involved and engaged, it will deteriorate fast in the future. To the question about regulation and consequences, there are new rules coming out, but we still have trouble meeting the ones that came out two or three years ago. What concerns me now are the consequences of not complying and the degree and amount of fines that are coming out; we’ve seen some astronomical fines. It used to be that a $100,000 fine was big; now it’s the minimum entry point. It’s not like, “OK, you stole clients’ money, so you’re going to pay a lot of money.” Instead, it’s, “You lost some emails,” and now you’re dealing with a multimillion dollar fine. It’s definitely not a friendly environment at this stage on the broker-dealer side. On the RIA side, it’s still relatively OK by comparison.

Advocacy: Into the Breach

Sullivan: What would you like to see FSI do better? Are they effective or could they be more effective?

Schwartz: I was a founder and on the board of directors for seven years, so I may be biased. I think they’ve stepped up compared to when I was there. The organization is multiple times larger and reaching its tentacles out a lot more, which is necessary since you’ve got all these new players: the DOL and the SEC, all the different states and all the moving parts. They’re as effective as they can be at what they’re doing. They’re getting the issues, they’re making a difference, but there are some items that are so big that no matter who you are, you cannot turn certain things. Thank goodness FSI exists because without it we’d have no representation at all. Regulators see the FSI as a level-headed organization that brings a balanced approach to things.

Murphy: I’ve been involved with the FSI board over the last few years, and we’ve seen the organization mature and develop. We now have 36,000 advisor members. That’s brought a number of resources to the table. We have a larger constituency with which to effect change locally, and it’s given the organization tremendous financial resources. We’ve relocated the organization from Atlanta to Washington D.C., which has been tremendously effective, and then hiring high-quality folks to be more effective. We’ve seen the organization grow and develop and move forward. Dale [Brown, FSI’s president and CEO] is always constructive and never wants to be an outlier. I expect you’re going to continue to see the FSI be a credible resource for industry regulators, and we’ve had responsible, constructive engagement with them.

Green: Is growing the actual advisor membership crucial to affecting how people on the Hill respond to issues?

Murphy: It is, and I would encourage any firm to have their advisors join the organization because with the 100 or so member firms, we still only have about a third of the advisor population’s numbers. It’s much more effective when we go on visits to the Hill to have an actual constituent of the representative or the senator with whom you’re meeting.

Diachok: I think the organization’s done a very good job in continuing to grow the advisor base, which will help provide additional revenue. It can only improve to have more boots on the ground to stand up for us as best we can as an industry.

Frank: They just sent an email out last week about the independent contractor rule. I sent it out to all of our reps telling them that this could happen, and advising them to send a letter to their senator. FSI made it very easy to go out to the grassroots.

The Independent Broker-Dealer Model: Past, Present and Future

Green: Do you feel pretty good about the future of independent broker-dealer model and the various affiliation options?

Frank: I think it’s just a matter of patience and giving reps the right products. This was a tough year for recruiting [a point to which all the leaders concurred.-Ed.]. It’s a tough year if you’re not in hybrid RIAs; we’re fighting different channels to find reps and not getting as many as we want. The ones that seem to always get in trouble are the private placements and REITs. We don’t allow that. If you can’t sell it tomorrow in an open market, we’re not going to send it to you. While that takes revenues out of our pockets, longer term I think it’s a smarter, more conservative move. This wave of hybrid RIAs, which started a few years ago, is working well, but the more people who do it, and the more attention it gets, someone’s going to come down on it.

Schwartz: I think it’s a great model. Certainly, it’s still growing, although not as wildly as in its early days. It’s in more of a mature stage. The biggest factor determining its future, compared to other primary channels, is regulation. If regulations on fee-only RIAs continues to be minimal and the cost is low, then that side will grow faster. If suddenly they put FINRA in charge of RIAs and they get audited every year and they have to have email reviews and fines and all the things we have, then they would grow more slowly and the independent channel will grow faster.

Given consolidation, another major trend, the survivors are the ones that will have either a very specific, narrow niche or have really strong solutions in both fee-based and commission-based, in practice management, in social media, in all those different categories that advisors expect now out of an independent broker-dealer. Twenty years ago [advisors said], “Don’t lose my check and pay me on time.” The advisor now is asking, “What have you done to help me grow my business?”

Diachok: The demographics and the trends within the industry bode well for us. The question is how we conduct our business and will there be any disruptive entrants into the market. Technology has leveled the playing field over the last 20 years from wirehouses to independent firms. Now anyone with billions of dollars could enter the market and capture the younger generation. We have to be flexible with the way we conduct our business and understand what the advisor needs. The very nature of our business is that we’re entrepreneurial. By nature, we’ll be able to adapt and change.

Schwartz: In the end, the public wants independent, objective advice, and I think that’s been associated with the independent model being fee-only; that trend is pushing our success. Who will be the winners in that is based on a lot of things, but one of the clear trends is consolidation. The independent space is going to look different in 15 years. There are going to be seven or eight firms that control 90% of the space. Fifteen years ago there were 10 firms that controlled 20%. That’s just what happens; you look at the car industry, or wire firms. That doesn’t mean some firms can’t be doing $50 or $100 million and making a nice profit. That’s still 1%. With Cetera’s recent acquisition, they became one of the $4 billion-plus firms.

I can’t speak for the others [Broker-Dealer of the Year winners], but in our firm we’re trying to be one of the six or seven, but due to organic growth, not due to the acquisition model, and by being just a little ahead of the curve on some things like the hybrid model.

Ownership Models: Going for the Brass Ring

Green: Another trend, since you mentioned Cetera, is the purchase of IBDs by private equity firms. How do you feel about private equity’s growing interest in your business?

Murphy: I have mixed feelings about private equity. I think consolidating efficiencies within a portfolio of firms improves those firms, but it depends on their view. Is it a long-term investment or is it a trade? I’d like to remain independent. I’d like my organization to be here in 20 or 30 years and run in the same fashion. I don’t necessarily see Investors Capital as a top 10 firm. We’ll probably remain as a niche player. We have revenue growth goals. We want to be that high-service, high-touch firm. When you’ve got a private equity firm, my fear is that it might be more driven toward economics.

Frank: I think it’ll swing the pendulum back to helping create opportunities for smaller BDs with deeper pockets. They’ll be able to go after and recruit those reps that want a more hands-on touch like our three firms.

Schwartz: In the long run, I am strongly negative on [private equity in the independent BD space]. In some cases, they took some very weak broker-dealers and made them better, but to me, the entire value proposition of Cambridge is based on our independent ownership. I’ve created an estate plan and long-term plan to keep it independent for multiple generations of ownership. I’m passionate about it because when firms get bought by insurance companies or by any kind of private equity or go public, their first loyalty has to be to ownership. When I look at some of the competitors that I’m taking huge numbers of reps from today, it’s usually somewhere between two and eight years after they were bought by a large company or venture firm. The reps are saying the culture’s lost. The day that they can’t call up senior management or that senior management’s first loyalty is getting a 25% return, in my mind, is the beginning of the end.

Diachok: I think we’re all here because we have that culture. We’re not owned by a big private equity firm. It’s tougher to provide that personal level of service that advisors are looking for in firms that are part of some of these private equity conglomerates.

Products and Strategies: Are There Alternatives to Alternatives?

Sullivan: What’s happening from a macro view? Are you finally seeing the rotation out of fixed income, and if so, into where: equities, alternatives?

Murphy: It’s hard for us as a firm to direct where advisors are positioning their clients. We’re seeing a rotation out of fixed income. As we said earlier, in light of the recruiting, we’re getting better results in the markets. We’ve see a greater amount of equity flows in the last six to eight months than we had seen in a long time.

Schwartz: Alternatives have been hot, but these REITs that have [attracted] so much [money] in a short time— it’s a little scary. A few of our competitors have shut down because of the sheer dollars they put into them. Fortunately our advisors tend to be a little more toward the broader asset allocation model. Flows have definitely been toward equities in the last six to eight months and a little bit away from classic bonds. Alternatives have had an uptick for five years, but they’ve also had an even further uptick recently.

Green: What are alternatives, by the way?

Frank: Anything you can’t sell tomorrow.

Murphy: I think in different industries, you’re going to have different definitions. For us, it’s oil and gas, it’s real estate investments and it’s managed futures.

Schwartz: You’ve got stocks, bonds and cash, and then you’ve got everything else, and to some degree all of those are alternatives. If you looked at it five years ago, stocks and bonds had done badly for a while, and alternatives got a new life. It had pulled back some because the stock market started doing so well, but then the recent success of some of these IPOs and REITs started coming in at over 100% of their value, and it set off a feeding frenzy to some degree.

Green: Tim, you said it’s not your job to tell reps what to invest in, but you want to be sure that whatever they’re investing in is appropriate, correct?

Murphy: It’s interesting; we provide guides and access to information, however, we’re not making recommendations. We’re not saying this is the hot stock or the hot alternative product or the asset allocation that you need to be in. We provide them with access to vendors and research, but we make sure that what they’re doing is not inappropriate. We won’t tell them what they should do, but we will tell them what they can’t do.

Green: Do you have to provide access to IPOs, private equity and other alternative investments in order to stay competitive?

Frank: Maybe 1% of reps are qualified to even look at some of these things. It’s been our philosophy that if you can’t sell it on the open market tomorrow, Century doesn’t want to show it to the reps. Now they’re coming out with mutual funds that are hedge funds. What type of manager is going to give away all his secrets? So you’re probably going to get lesser managers running these funds, and those are going into fee-based models. That worries me.

Green: Then why alternatives? Do you just want something that’s non-correlated to the broader markets?

Schwartz: That’s an important part of it. Global markets have gone the same way as in the last downturn. If you were in stocks and bonds almost anywhere in the world, you were losing money. So it would be wise to have some amount in alternatives that have a low correlation or are reverse-correlated.

If you want to compete in the broader market for advisors today, it’s a very rare firm that’s going to have none of those alternatives available. We are forced to have some number of alternatives, even if we were personally opposed to them and would never invest in them. You’re in the business of providing advisors and clients a broad diversity.

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